Reporting on recent legal developments and trends in the oil and gas industry

Tag Archives: lease

On March 5, 2018, the West Virginia Legislature passed new legislation known as the Cotenancy Modernization and Majority Protection Act, W. Va. Code § 37B-1-1 et seq. (Cotenancy Statute). This new Cotenancy Statute, which became effective June 3, 2018, is intended to facilitate oil and gas development of West Virginia properties that have numerous fractional oil and gas owners. It applies to tracts in which there are seven or more owners of the oil and gas in place, and changes West Virginia law by allowing an operator to produce oil and gas without the consent of all oil and gas owners under certain circumstances.

Background

Prior to passage of the Cotenancy Statute, West Virginia law mandated consent of 100 percent of the oil and gas owners before an operator could lawfully develop the oil and gas estate. If any oil and gas owner refused to sign a lease, regardless of how small that non-consenting owner’s fractional interest, the operator was compelled to either forego development or file a partition action under W. Va. Code § 37-4-3. Through partition, an operator could acquire the non-consenting owner’s interest at fair market value, as appraised by three special commissioners appointed by the court.…

On Feb. 17, 2017, the 7th District Court of Appeals upheld a Mahoning County Court of Common Pleas decision that ruled landmen must be licensed as real estate brokers to be compensated for negotiating oil and gas leases.

In Dundics v. Eric Petroleum Corp., 2017-Ohio-640, the plaintiffs were landmen who had negotiated leases on behalf of the defendant operator. The landmen were promised $10 per leased acre and a 1 percent working interest in any wells placed on the leased acreage. In the landmen’s suit for failure of payment, the operator successfully moved to dismiss the case on the basis that the landmen were not entitled to compensation since they were not licensed real estate brokers. The operator pointed to Ohio Revised Code Section 4735.21 in support of its motion to dismiss, which states in part:

“[n]o real estate salesperson … shall collect any money in connection with any real estate or foreign real estate brokerage transaction, whether as a commission, deposit, payment, rental, or otherwise, except in the name of and with the consent of the licensed real estate broker or licensed foreign real estate dealer under whom the salesperson is licensed at the time the sales person earned the commission.”

This morning the Ohio Supreme Court issued a decision in Lutz, which arose when the federal Northern District Court of Ohio, Eastern Division, certified the following question of law to the Ohio Supreme Court: Does Ohio follow the “at the well” rule (which permits the deduction of postproduction costs) or does it follow some version of the “marketable product” rule (which limits the deduction of post-production costs under certain circumstances)?

The Supreme Court initially accepted the certified question and the issue was fully briefed and argued earlier this year. However, this morning the Court declined to make a blanket ruling regarding allocation of post-production costs. The Court concluded, “Under Ohio law, an oil and gas lease is a contract that is subject to the traditional rules of contract construction. Because the rights and remedies of the parties are controlled by the specific language of their lease agreement, we decline to answer the certified question.” This essentially leaves the issue to the trial courts to decide, on a case by case basis, how the parties to a lease intended to allocate post-production costs.

Justice O’Neill dissented, explaining that he believes the court should have adopted the “at the well” rule, thereby allowing a lessee to deduct post-production costs from a lessor’s royalty. Justice Pfeifer also dissented, commenting that he would have liked the Court to answer the certified question by adopting the “marketable product rule,” thereby forcing lessees to bear the burden of all post-production costs.…

The Ohio shale boom started slowly when a few small companies quietly began acquiring mineral leases for as little as $25 per acre. This soon gave way to a full blown land rush in the fall of 2010. But as lease prices skyrocketed through the Fall of 2011, disillusioned lessors who signed before the peak of the market were the ones rushing – to the courthouse to file lawsuits to cancel their leases.

In order to gain leverage and legitimize their lawsuit, lessors frequently allege that their lease is “unconscionable” or they were fraudulently induced to sign it. “Exhibit A” to these lawsuits is often a technical error in the lease signing or a “fraudulent” statement made by a landman. There are exceptions, but many of these kinds of lawsuits have no legal basis.…

In Eastern Ohio, before 2010, a customary signing bonus for an oil and gas lease was usually less than $25 per acre, as it had been for years. By the fall of 2011, after the shale boom hit, lease bonus prices had risen in leaps and bounds to their peak (so far) of about $6,000 per acre before pulling back significantly in the spring of 2012.

Naturally, everyone who did not have the foresight or nerve to hold out for $6,000 per acre was left feeling more than a little miffed. After all, a typical bonus check on a 100 acre parcel in 2009 or early 2010 would have been $2,500 but that bonus may have swelled to $600,000 in less than two years!

Courts Do Not Decide What is “Enough”

Fortunately for our economy and legal system, a party to a contract cannot later adjust the contract price when they finally realize the value of a transaction. In fact, it is the imbalance of information, risk tolerance, and vision among different people that is the driving force of business in the United States.

But even reasonable lessors were overwhelmed by the incredible disparity between lease bonuses paid during the shale boom. That disparity, combined with the belief that the oil and gas companies have bottomless bank accounts, spawned lawsuits by lessors to try to break leases with the hope of signing for more.

Of course, breaking contracts requires more than just a lot of hard feelings about not getting …

The Point: Oil and gas leases are specialized instruments of real estate and contract law. The very existence of the lease can turn on court opinions over 100 years old (with little between now and then) and the court’s interpretation of something as ephemeral as “good faith” can be determinative. Curative documents, a royalty check endorsement, division orders and the like may clarify ambiguities when a lot of money is at stake.

Discussion:The relationship between the owner of minerals (which may be different from the owner of the surface, the subject of a future blog) and the oil company is typically defined in and oil and gas lease where the Owner, in a contract, grants to Lessee defined rights to the property in exchange for promises and money. The length of the lease, the term, is addressed in one of the most important provisions the lease — the “habendum” or term clause, which usually appears near the beginning of the lease. The term clause in an oil and gas lease is the product of long development and experience. It attempts to reconcile the competing interests of the parties. Owner wants a well and its royalty payments quickly (a short term) while Lessee wants flexibility and as much time as possible (a long term). Given the new interest in oil and gas production in Ohio, it is crucial to understand the term clause for both old/existing leases and new ones.…

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